RED MEAT OUTLOOK: Cautious Optimism

January 12, 2010
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by Steve Kay

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Start with a spoonful of slowly improving demand, add a few ounces of operating efficiencies and throw in a cup of cautious optimism. This seems to be the recipe for how U.S. red-meat processors will perform in 2010.

On the surface, the outlook for beef and pork looks brighter than a year ago. Last January, the full throes of the U.S. and global recession were just being felt. What subsequently occurred was a recession that was deeper than most forecasts. This impacted domestic beef and pork demand and cut exports sharply in both meats. At the same time, drought cut cattle numbers in key beef-producing countries. Trade restrictions and outright bans still hindered the global meat trade. At home, E. coli O157:H7 still hung over the industry. This forced the industry to defend itself against a new breed of advocacy journalism and members of Congress who called for new food-safety rules.

Remarkably though, the red-meat industry not only survived 2009, some beef processors even made record profits. Even pork processors, who depend more on the fresh than the processed meats market, made money. The profits, though, came at the expense of cattle feeders and hog producers, who saw as much as $5 billion in equity drained from their businesses during the year.

This caused a continued reduction of the U.S. cattle herd and a slightly larger liquidation of the U.S. sow herd as the year progressed. Market-ready numbers of cattle and hogs will likely decline only slightly in the first half of 2010. But they will tighten more in the second half. In 2010, profitability in beef and pork processing and further processing will depend on companies being able to wring more costs out of their operations and on improved demand at home and abroad. Selling prices will need to be moderately higher in 2010 to offset higher cattle and hog prices.

Looking back

A recap of 2009 is necessary to evaluate how the red-meat business might perform this year. A decline in GDP (gross domestic product) in most countries except China in 2009 shrunk overall world trade by 6 percent, according to the Economist Economic Unit. This, in part, caused U.S. beef exports to decline, despite the weak dollar. A November USDA projection put exports for the year down 3.3 percent. However, actual data for January through the end of October had volumes down 12 percent and value down 18 percent, compared to the same period in 2008. Much of the decline was in beef variety meats. USDA in November forecast that exports this year will be 5 percent higher than in 2009.

Japan was the bright spot in 2009, with volume and value up 22 percent through October. Further increases in 2010 will depend on an improvement in the Japanese economy, the value of the dollar versus the yen and on whether Japan agrees to relax its age restriction on U.S. exports. The U.S. government has urged Japan to lift the restriction – currently only beef products from cattle under 21 months of age can be shipped. There are still differences of opinion in the U.S. over pushing for the removal of all age restrictions or accepting an under-30 month restriction as the next step. The industry wants the latter, as this would qualify for export 90 percent of all fed cattle slaughtered. Japan in 2009 showed little interest in discussing the subject, but the U.S. is likely to pres harder this year on this issue.

Beef exports in 2009 were also up to Taiwan, Hong Kong and Vietnam. But they were down 28 percent in volume and 36 percent in value to Mexico, down 10 percent in volume and 15 percent in value to Canada, and down 47 percent in volume and 69 percent in value to Russia. Business is likely to improve to Mexico this year but exports to Canada and Russia might not recover much.

As in 2009, more Canadian cattle are likely to be processed in Canada than in prior years. This is largely because the cost of mandatory country-of-origin-labeling has forced U.S packers to discount Canadian cattle. As a result, Canadian cattle imports to the U.S. in 2009 (until the end of November) were down 33 percent on the same period in 2008.

Pork exports in 2009 fell slightly less than beef. USDA in November projected an 11.4 percent decline in volume. This was the percentage decline in actual imports January through October, with a 13 percent decline in value. USDA forecasts a 7.6 percent rebound in 2010, although exports for the year will still be nearly 5 percent below 2008’s record levels. Japan was also the key country for U.S. pork exports. Volume was down slightly on 2008 through October but values were up 1 percent. Some predicted the U.S. would sell Japan a record $1.55 billion of pork in 2009. China recently agreed to allow U.S. pork into the country again, after an H1N1-induced ban. But it is expected to buy only small amounts of U.S. pork this year. Russia meanwhile banned imports from a growing number of U.S. plants in November and December so little pork might be sent to the U.S.’s sixth-largest export market for a while.

Segment specifics

Of the major proteins, beef suffered most in 2009 because it is the highest priced. Packers worked assiduously to match supply with demand, one reason why they made money. Production in 2009 was down 3.1 percent on the year before. But pork production was down only 1.8 percent. So, the wholesale price spread between beef and pork was at times historically large. This spread began to narrow in November and is likely to shrink somewhat more in the first half of 2010.

Exacerbating beef’s struggles was the fact that American consumers lost billions of dollars in equity in homes and retirement funds, and became savers not spenders. This caused them to eat out less and trade down in their meat purchases in the grocery store. The result was that beef demand at foodservice, from white-tablecloth restaurants to steakhouse chains and family-style restaurants, suffered the biggest hit. Not surprisingly, hamburger chains fared best in this sector, one reason why manufacturing beef prices remained strong all year relative to middle meats.

Although consumers spent proportionately more of their food dollars in grocery stores than in restaurants, retail beef demand still declined by 5.6 percent in 2009 vs. 2008. Retailers were forced to feature more beef just to generate sales. This, plus the huge decline in foodservice demand and the 12 percent slide in exports, meant that overall beef demand in 2009 declined 10 percent on 2008, returning it to its 1998 level, says analyst Andrew Gottschalk, HedgersEdge.com.

Beef demand will look better in 2010 but only because 2008’s numbers were so bad. Even so, the degree and pace of the improvement is the key issue. Exports will be higher, but domestic demand might remain at its currently depressed level at least though the first half of the year, says Gottschalk.

The reason for the very slow recovery can be summed up in one word: jobs. Millions of Americans lost them in 2009. The unemployment rate was 10.2 percent in October and 10.0 percent in November, with 7.3 million having lost their jobs since December 2007. Add in the under-employed and the rate rocketed to 17 percent of the workforce. Meanwhile, a record 36 million Americans were on food stamps by the fall, up 46 percent from two years earlier. In November, USDA declared that a record 49 million people were “food insecure” in 2008. This number doubtless increased sharply in 2009.

The Obama Administration became so concerned about the increasing jobless rate that it was by late November considering a huge stimulus package to create new jobs. But this and the re-employment of laid-off workers will be slow, say economists. Yet, only when unemployment levels decline will Americans start to feel more confident about the economy and start spending more money. This suggests only a gradual increase in spending on beef in 2010.

As noted, the supply side of the beef and pork industry responded to the recession. Drought, increased production costs and financial losses caused cow-calf producers to reduce their herds in 2009. The U.S. herd from Jan. 1, 2008 to the same date in 2010 might have declined by as much as 3 million head. The North American herd (adding Canada and Mexico) is likely to have declined by 4.8 million head. But U.S. beef production the first half of 2010 is expected to be up slightly on 2009’s first half, say analysts. Most have production forecasts higher than those projected by USDA. The increase will reflect year-on-year increased feedlot placements from last July through October and increased carcass weights, which set new records last October. Production though will decline about 1 percent in the second half of the year. Some analysts say beef production for the year will be down only 0.2 percent while USDA projects a 1.4 percent decline.

Cow-calf producers lost about $20 per cow in 2009, the same as in 2008, says the Livestock Marketing Information Center. Calf prices were the lowest since 2003. This helped alleviate but did not prevent heavy cattle feeding losses because of high corn prices and a lower than expected live (fed) cattle market. LMIC projected that feeding losses exceeded $2.4 billion or $90 per head, the second biggest losses after 2008.

Pork producers began losing money in 2008 and the red ink deepened in 2009. The relatively small sow herd liquidation surprised many analysts. Some estimated that producers lost nearly $5 billion equity in the 27 months to the end of December and face more losses in 2010. The losses topped the market crisis of 1998-99, says Univ. of Missouri economist Ron Plain.

Largest producer Smithfield Foods led the liquidation phase by culling 131,000 sows from its one million sow herd. Several other top operations followed suit, but many other producers appeared to hold their numbers steady. The top 25 operations in 2009 cut their sow herds by 6.5 percent, says Plain. But the national average was only 3.4 percent. Counter-balancing the cuts in 2009 were improved productions efficiencies (up by 3.5 percent per sow). So the pork industry is likely to struggle with too many hogs and too much pork well into 2010, say analysts.

That’s why USDA pegged 2009 pork production down only 1.3 percent from 2008. It has 2010 production down 2.7 percent. One of the ironies is that the industry needed this kind of decline last year. Yet, this year might see a surge in exports if USDA’s 7.6 percent increase proves accurate. This would suggest pork will be more expensive on the domestic market in 2010, as there will be less available. USDA pegs the amount (called disappearance) at 47.1 pounds per person, vs. 49.9 pounds in 2009. Beef disappearance will also be down because of reduced production and larger exports. At a projected 60 pounds per person, versus 61.3 pounds in 2009, it will be the lowest beef disappearance figure in at least 50 years. It appears that Americans will continue to eat more pork and chicken, relative to beef, in 2010 than in 2009.

Beef’s bright side

Beef packers, as noted, made surprisingly robust profits in 2009 despite the decline in cattle numbers and beef demand. They replaced a long-time battle for market share with a new mantra, managing and optimizing margins. The result was that Tyson Foods, the largest processor in terms of sales, made $214 million in operating income in beef for the year to October 3. That went against income of $106 million in fiscal 2008. JBS USA Beef (including Australia) for the first nine months of 2009 had EBITDA (earnings before interest, taxation, depreciation and amortization) of $273 million, versus $260 million in the same period in 2008.

National Beef Packing outperformed them both relative to its size. As the fourth-largest beef processor, its sales are nearly half that of Tyson Beef. But it had a record $143 million in net income in its year ended August 29. It has now reported net income of $481 million in seven years. Such results suggest its $300 million initial public offering, which it launched in early December, would be well supported. JBS USA also plans to launch its proposed $2 billion IPO sometime early this year.

Beef demand looks set to improve only modestly in 2010. So packers might be hard-pressed to replicate 2009’s profits because of the gradual tightening of both fed cattle and non-fed cattle supplies. The two-year decline in cattle numbers represents the throughput of two 6,000 head per day slaughter plants. Packers will have to wring more efficiencies from their operations and manage even more closely the spread between raw material costs and selling prices. One way they did this in 2009 was to operate more efficiently Monday through Friday and to reduce their Saturday kills. The weekend kills averaged only 20,000 head in 2009 (excluding holiday weeks), half the average of years in the past when cattle numbers were much higher.

The pressure on the industry’s cattle feedlots will be more intense. USDA puts the one-time feeding capacity in 1,000 head and larger yards at 16.6 million head. These feedlots had 11.3 million cattle on feed on Dec. 1, a 68 percent occupancy rate. As mentioned, the North American cattle herd will continue to shrink and expansion might not show up until 2013 at the earliest. Over-capacity and financial losses are likely to force numerous feedlots to close. But feedlots also face escalating environmental costs under expanded CAFO (concentrated animal feeding operations) regulations. Feedlots since November 2008 have been required to have a nutrient management plan for manure and wastewater disposal. Coming into and staying in compliance with the new regulations could put many smaller feedlots out of business because of their higher per head cost of compliance, say observers.

Pork processors, especially those with significant processed meats businesses, made solid profits in 2009 and are likely to do so again in 2010. Largest processor Smithfield Foods’ pork division reported operating income of $449.4 million in fiscal 2009 (year ended May 3), with record profits in packaged meats. The division had operating income of $275 million for the first six months of fiscal 2010, with packaged meats a record $239 million, vs. only $74.4 million in the year earlier period. This revealed how Smithfield continues to move toward being more of a consumer-products food company.

Smithfield, though, is also the nation’s largest hog producer and its huge hog losses ($521 million in fiscal 2009) continued to mount in fiscal 2010. It reported an operating loss of $329 million for the first six months, vs. a loss of $97 million in the same period in fiscal 2009. Tyson Foods’ pork segment had operating income of $160 million in fiscal 2009, while JBS USA Pork had EBITDA of $47.5 million.

Livestock producers and packers are sometimes at odds with each other, but they share a common trait. They are great survivors. Each sector will be hoping that economic recovery this year will lead to improved demand for beef and pork, particularly at home for beef. The key to any improvement in beef demand is a recovery in the restaurant business. The red-meat industry rolled out several promising new products in 2009, such as the Philly Cheese Steak Roll and Tyson’s Skillet Creations and Charbroil Beef Patties. The industry will need to develop even more high-margin items this year. The theme for 2010 is that to remain profitable, the industry will have to do more with less.

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